Structured product

Abstract: In this paper, we first show that for classical rational investors with correct beliefs and constant absolute or constant relative risk aversion, the utility gains from structured products over and above a portfolio consisting of the risk-free asset and the market portfolio are typically much smaller than their fees. This result holds irrespectively of whether the investors can continuously trade the risk-free asset and the market portfolio at no costs or whether they can just buy the assets and hold them to maturity of the structured product. However, when considering behavioural utility functions, such as prospect theory, or investors with incorrect beliefs (arising from probability weighting or probability misestimation), the utility gain can be sizable.

Abstract: This paper is the first to measure individual investors’ realized risk-adjusted performance in structured financial products, which represent one of the key financial innovations in recent times. Based on a large database of trades and portfolio holdings for 10,652 retail investors in discount and bonus certificates and common stocks, we find that (1) investors typically realize negative alphas in structured financial products, even when transaction costs are ignored. (2) Their underperformance increases with product complexity, which results from the higher implicit price premiums charged by the issuing banks for the more complex products and from the investors’ poor selection of products that have complex payoff specifications. (3) Investors also make poor choices when selecting the underlying assets for their structured product investments. This is merely a reflection of the poor stock selection abilities which also leads to a significant underperformance for their equity portfolios. (4) Certificate and stock investors are prone to the disposition effect. Overall, these findings suggest that retail investors may require some form of protection to avoid incurring these losses.

Abstract: A novel equilibrium theory is developed for two price markets permitting investors to trade personally designed structured products. Classical market clearing is enhanced for structured products where the market allows these products to be freely bought at ask prices or sold for bid prices. Competitive pressures lead the market to lower the ask prices and raise the bid prices with the market offering individual investors the widest possible set of acceptable risks provided the aggregate counter cash flow held by the market is consistent with a more conservative prespecified set of acceptable risks. We learn that in equilibrium heterogeneous investors inherit a common hedging objective of maximizing the bid prices of the final structured product sold to market or equivalently minimizing the ask price of what is bought.

Abstract: This paper is the first to measure individual investors’ realized risk-adjusted performance in structured financial products, which represent one of the key financial innovations in recent times. Based on a large database of trades and portfolio holdings for 10,652 retail investors in discount and bonus certificates and common stocks, we find that (1) investors typically realize negative alphas in structured financial products, even when transaction costs are ignored. (2) Their underperformance increases with product complexity, which results from the higher implicit price premiums charged by the issuing banks for the more complex products and from the investors’ poor selection of products that have complex payoff specifications. (3) Investors also make poor choices when selecting the underlying assets for their structured product investments. This is merely a reflection of the poor stock selection abilities which also leads to a significant underperformance for their equity portfolios. (4) Certificate and stock investors are prone to the disposition effect. Overall, these findings suggest that retail investors may require some form of protection to avoid incurring these losses.